28 February 2020
To prevent double spending issues of various cryptocurrencies and safeguard blockchain's decentralization feature, it is important to ensure that all nodes in the network share common agreement about the present state of the blockchain. This agreement is achieved by various consensus algorithms like Proof of work (PoW), Proof of Stake (PoS), Proof of Burn (PoB) and Proof of Authority (PoA), etc.
Proof of work (PoW) is a consensus algorithm that involves solving a complex cryptographic puzzle. The first user to solve the puzzle gets the mining right. But this process consumes a large amount of electricity and time along with costly mining hardware that hampers the approach of PoW. Proof of Stake (PoS) is another algorithm in which the mining power is directly proportional to the cryptocurrency stake offered by the user. The more stake amount the more chances of getting mining right
Similarly, Proof of Burn (PoB) is a consensus algorithm created by Lain Stewart with an aim to show the energy consumption issue of PoW. In this mechanism, the users “burn” or “destroy” some of the mined PoW cryptocurrency. In simpler terms, it is a process of sending a small amount of cryptocurrency in a wallet that has an un-spendable address — an address not under the control of anyone (also termed as Eater address). This address is randomly generated with no private key association. So without a private key the coin, the coins sent in the address access or spent. Eater address is simply used to store coins which cannot be used in the future. These coins are permanently removed from circulation but remain in the calculated supply.
In PoB, when a miner decides to burn coins that means he/she is willing to take a long-term gains/advantage by incurring a short-term loss (i.e. burning coins). During such burning a virtual mining rig is given that mines on behalf of you without wasting resources as PoW rig does. More the number of coins that are burnt more powerful is the mining rig thereby increasing their further rewards. The power of these rigs decays or decreases partially like ASIC (Application-Specific Integrated Circuit) and become obsolete over time. Due to these, miners remain active and invest in the rigs periodically.
Why Coins are burnt?
1. For creating new coins: Some coins like Counterparty (XCP) cannot be mined so they are generated after burning Bitcoins. Once a certain amount of bitcoins is sent to an unspendable address, in return Counterparty (XCP) is generated on the bitcoin blockchain. Thus indirectly increases the value of XCP as burnt bitcoins becomes of no value.
2. For rewarding the coin/token holders: This is based on the law of demand and supply. Sometimes an artificial scarcity of cryptocurrency supply is created so that the holders of that cryptocurrency get huge benefits. This is generally practiced in the USA and some other countries as rewarding different cryptos as direct dividends to token holders is not permitted.
3. For destroying unsold coins after an ICO or token sale: Some coins are not sold after ICO’s or token sale, so it is necessary to burn these coins as companies may take advantage and sell them at a higher rate. Thus, to maintain a fair play the coins are burned.
- PoB encourages long-term commitment thereby creating greater price stability of the coin, as long-term investors are less likely to sell their coins.
- PoB ensures that the coins are distributed fairly and in a decentralized manner.
- There is no guarantee that the user will recover the equivalent amount of the coin burnt.
Proof of Burn is a method that helps in reaching the consensus, safeguarding the decentralized nature of the network without wasting the natural resources.